It was a good week to be a Whole Foods shareholder. The pioneering organic grocer may have escaped the limits of its business model by selling itself to Amazon at a 25% premium to current share prices. Activist shareholders who had been pressuring Whole Foods CEO John Mackey to sell the company have gotten their wish.
What has Amazon bought? First, growth. The company has been interested in the grocery category for some time. It sells many non-perishable items on its website, and the AmazonFresh delivery service has expanded into a range of perishables. Bloomberg estimates U.S. food and beverages was a $795B category in 2016. It also estimates that Amazon captured only 0.8% of this number. Compare this to the estimated 17% share of consumer electronics sales that Amazon obtained in 2015.
Every sizable company eventually faces the choice between building growth out of its own operations (“organic growth”) or buying growth by purchasing someone else (“inorganic growth”). The tradeoff is that buying is usually faster but more expensive, while building growth is cheaper but slower. In its last two annual reports, Whole Foods indicates it opened 66 new stores while spending $911 million on the development cost of new locations.
Could Amazon spend a few billion dollars building stores? Sure. Its operating cash flow in 2016 was $16 billion. They opened the first of a planned set of Amazon Go stores carrying groceries in Seattle earlier this year. But how long would it take, and where would those stores be? Meanwhile, using Bloomberg numbers, Amazon has more than doubled its market share of food and beverages with one acquisition.
The relief Whole Foods shareholders may be feeling arises from the fact that it's not clear how good a business Amazon has bought. Whole Foods has been struggling in recent years. Its same-store sales, an important retail metric, actually declined in fiscal 2016, suggesting a combination of peak consumer penetration and increasing competition are limiting the growth of existing locations. This means the only way Whole Foods can achieve growth is by opening new stores. But, as noted earlier, new stores are expensive. Profit has also been declining at the firm.
Can Amazon fix the Whole Foods business? There are some strong potential synergies to the acquisition. Beyond stores, Whole Foods has a strong, well-known brand and remains profitable despite slow growth. In 2014 Interbrand estimated the brand was worth $4.1B. Two-thirds of Whole Foods sales are in perishables such as baked goods and produce, complementing Amazon's strength in non-perishables. At a broader level, Whole Foods stores are located largely in well-off urban areas that are likely to be home to many Amazon Prime customers; it's easy to imagine special deals at Whole Foods for Prime customers and the use of the Whole Foods locations to improve inventory and logistics for Amazon Fresh.
Meanwhile, Amazon brings a formidable technology and supply chain infrastructure, a ruthlessly efficient culture, and unparalleled knowledge of consumers to the Whole Foods brand. The initial announcement indicates that Amazon will let Whole Foods continue to run largely as a standalone business with Mackey at the helm. I don't expect that decision to stand. Some analysts are already suggesting Amazon will use its strengths to reduce Whole Foods' infamously high prices. If anyone can improve Whole Foods profitability, it's Amazon.
At a broader level, the more important asset Amazon has bought is a pipeline to well-off urban consumers. Amazon's business is ultimately about building pipelines through which it can drive as many sales as possible. The website started with books, but by 2014 had expanded to a kaleidoscope of over 230 million items for sale. The digital selling infrastructure became a streaming infrastructure for media and games. The Kindle Fire tablet, sold at manufacturing cost, is a portable window into the Amazon storefront; that and the Amazon app mean the store is always with you. And Amazon Echo puts the store within the sound of your voice.
I expect Whole Foods stores will become another pipeline for the sale and, importantly, the delivery and pick up of a broad range of Amazon goods beyond groceries. Billionaire entrepreneur Mark Cuban suggested on the day of the deal that Amazon wins when it can deliver goods faster than it takes consumers to get to the store and shop. This deal goes some way to helping Amazon win that race. So the Amazon Empire continues to grow, and all around it retailers shiver in fear.
